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MODERN BANKING 

Three Addresses delivered at 
Chautauqua, New York 



by 



FRANK A. VANDERLIP 

President, The National City Bank of New York 



August 
Nineteen Hundred and Eleven 



X^ 



HQjjj&Y 



WHAT IS A BANK? 



The importance of the part played by 
the banking business in the modern in- 
dustrial and commercial system is so 
obvious that it cannot be doubted even 
where it is but imperfectly understood. 
Its relations to a highly specialized 
society are analogous to those of the vital 
organs to the human body; when its func- 
tions are interrupted there is paralysis 
throughout the system. 

The lower forms of life are so simple 
that you may cut through them and sub- 
divide them at will without any impair- 
ment of vitality, but as organization de- 
velops, with a circulatory system and co- 
ordinate functions for the several parts, 
this independence of the parts is lost. 
And so in a primitive society the indi- 
vidual is comparatively independent, but 
as organization takes place and special- 
ization proceeds and the exchanges of 



The Bank and Society 



civilized life develop, the well-being of 
the individual becomes more and more 
dependent upon the perfection and regu- 
larity and stability of the system by which 
the exchanges are made; and banking, 
through its various functions, is the most 
important agency to this end. 

These functions have been developed 
with the development of the exchanges 
and to provide facilities for handling the 
exchanges. They are a part of the neces- 
sary equipment of modern society, with- 
out which the present volume of trade, 
the existing distribution of population 
and the prevailing style and scale of living 
would be impossible. Our civilization is 
based upon the division of labor. Its 
industrial efficiency, its wealth of produc- 
tion, its comforts and luxuries and varietv 
of opportunity are the results of organ- 
ized and co-operative effort. If each 
member of the community, instead of 
supplying all his own wants, devotes him- 
self to one thing and all exchange these 

4 



Improved Facilities Desired 

surplus products with each other , the 
sum total of production and of their 
possessions is increased. By this arrange- 
ment individual aptitude and talent is 
encouraged, capital is utilized aimd the 
advantages of enlarged and systematic, 
production are secured. But economies; 
and improved facilities in the exchanges 
are as desirable as in production; in fact 
the people who are engaged in transpor- 
tation and trade and banking are engaged 
in producing the goods at the place of 
consumption. And the lower you can 
reduce the cost of making the exchanges 
the nearer you come to endowing each 
man with the skill of all the race and the 
resources of every land and clime. 

The first important requisite of com- 
mercial intercourse was a common meas- 
ure of value. Money was the first great 
facility of trade. Its convenience as a 
common means of payment was great, but 
the after effects were vastly more import- 
ant. It created a new language, the 
language of values, which compares with 



Money as a Standard of Values 

barter as speech does with sign language. 
It made prices and markets possible and 
enormously increased the possibilities of 
trade. Men could understand each other 
when they talked of values in terms of 
money, and in the precious metals they 
found a common denominator that 
brought all values into relation with each 
other. 

This use of money as a measure or 
resolvent of values soon extended far 
beyond its use as mere currency. 
Grain and cattle and cloth and per- 
sonal services could be valued and 
compared in terms of money and ex- 
changed without any money changing 
hands, or with only the balances paid in 
money; and this system of refined barter 
has developed until the commerce of the 
world revolves upon the grain of gold as 
an axis, with almost insignificant pay- 
ments of money. The system was com- 
plete when the credits arising from the 
sale of goods were dissociated from the 
goods and became a new and distinct 



Exchanges Settle Themselves 

species of property, which could be traded 
in, transferred, merged, or cancelled by 
corresponding debits. 

The fundamental feature of this system 
of settlements is the fact that in the long 
run the exchanges settle themselves. All 
sales are made for the purpose of obtain- 
ing the means of making purchases. 
Broadly speaking, all income is disbursed, 
either for current expenses or for invest- 
ments. The wage-earner pays out usually 
a large part of his income for living ex- 
penses and the rest in payments on a home 
or to a savings bank. The business man 
disburses his receipts for goods or mate- 
rials, labor, rents and the various costs of 
doing business, and the surplus to enlarge 
his business or for private expenditure or 
investment. Every item of one man's 
outgo is an item of another man's income 
and in the aggregate income and outgo 
must balance, both for individuals and 
communities. A country cannot continu- 
ally buy more than it sells or sell more 
than it buys unless there are compensating 



Fluctuations Occur 



transactions under other names. It would 
take the entire stock of gold in the United 
States to pay for the goods we import in 
a single year, if gold was the only means 
of payment; clearly foreigners could not 
continue year after year to sell to us in 
increasing volume unless they were taking 
payment in commodities which we pro- 
duce in corresponding supply. Fluctua- 
tions in the movement of commodities 
between countries and localities will 
naturally occur, resulting from the vary- 
ing yield of the crops and other conditions 
subject to change, and the temporary 
discrepancies are bridged over with 
money ; but the broad fact must be recog- 
nized that trade is essentially reciprocal, 
and therefore the credits and debits that 
arise in the exchanges, if they can be 
brought together, will practically offset 
and settle themselves. 

This task of bringing together the 
multitudinous transactions of the business 
world, in order that settlements may be 
effected without the risk of robbery and 



Antiquity of Exchange 



cost of transportation and loss of interest 
attendant upon payments in money, is one 
of the functions of banking, and perhaps 
the earliest one to be developed. Cer- 
tainly not only the Italian traders of the 
middle ages but the Romans before the 
Christian Era were familiar with the Bill 
of Exchange, for when Cicero was about 
to send his son to school at Athens he 
wrote to inquire "whether he can take a 
Bill for the money he will want in Athens* 
or whether he must take the money itself 
with him." This indicates that the settle- 
ments between distant cities were handled 
substantially then as now, by a system of 
book entries and offsets, if not through- 
banks like ours, through regular dealers 
in exchange. 

If a man in Athens had a payment to 
make to a resident of Rome and at the 
same time had a like payment coming to 
himself from another resident of Rome, 
obviously the simplest way to accomplish 
both settlements would be to have his 
Roman debtor pay his Roman creditor 



Rome the Ancient Clearing-House 

and send the receipt to Athens. Or if he 
had numerous dealings in Rome he might 
empower one agent to collect all that was 
coming to him and pay all that he was 
owing. But one man might not have both 
credit and debit transactions with differ- 
ent people in a distant city ; he might, like 
Cicero, be only a buyer, or he might be 
only a seller in that market; and so the 
exchange dealer was developed as the 
agency for bringing the debits and credits 
together. It is safe to say that on the 
very day that Cicero bought his bill on 
Athens some Athenian was buying a like 
bill on Rome, and when the two instru- 
ments reached their destinations they 
balanced and cancelled each other. 
Moreover, if Athens wanted to pay Alex- 
andria, or Damascus wanted to pay 
Corinth, it is likely that a bill on Rome 
was the medium, for it is easy to conceive 
that Rome in those days must have been 
the clearing-house of the world and that a 
credit there would be good anywhere. 
It doesn't take a mercantile community 

10 



Exchange Settlements 



long to understand facilities like these. 
It is probable that mercantile houses in 
the regular trade were the first to buy and 
sell credits in distant cities, but as the 
exchanges multiplied the traffic would 
naturally centralize in the hands of ex- 
clusive dealers, and the more so as the 
element of time became increasingly 
important and called for the employment 
of large capital. When Cicero bought 
his bill on Athens the exchange dealer 
sold his own credit for cash, but a Roman 
merchant forwarding a bill of goods to 
Athens might prefer to sell his prospec- 
tive credit for cash, in which case the 
exchange dealer would be buyer and have 
the credit to carry to maturity. This, as 
a matter of fact, is the common form of 
foreign exchange transactions, and it 
includes a larger service than the mere 
settlement of maturing credits. The 
exchange dealer has bought the account, 
and the shipper, instead of awaiting the 
delivery of the goods and the arrival of 
the remittance, comes into immediate 

11 



The Dealer in Credits 



possession of the proceeds and can turn 
them back into his business. Evidently 
a new and useful sub-division is here 
established in the circle of the exchanges. 
The manufacturer or merchant, having 
effected the sale and converted his goods 
into a credit in terms of money, is at the 
end of his function, and the sooner his 
capital is released from that transaction 
and returned to the field in which he is a 
specialist the better. The dealer in 
credits, or banker, whose specialty it is to 
arrange the liquidation of such credits, 
bringing them together by corresponding 
dates and places, now steps in and for 
a small consideration carries them to ma- 
turity and makes the collection. 

The advantages of settling the credits 
and debits of trade by this arrangement 
of offsets were doubtless more apparent 
at first where cross-payments were to be 
made between distant localities, but 
another development was under way 
which was destined to extend the S3 r stem 
to include practically all classes of pay- 

12 



Private Banks in Venice 



merits. That development was the 
growth of deposit banking. This type of 
banking was also known to the Romans 
in its primitive form, which was simply 
that of a safe deposit business. They had 
a custom of keeping coin with an agent 
and making payments by personal 
or written order, but the custodian had no 
right to use the funds on his own account. 
He was paid for his care-taking and the 
advantages to the depositor were in safety 
and convenience. An account which dates 
from 1584 of banking in Venice says: 
"Buyer and seller are satisfied in a 
moment, while the pen moves over the 
page; whereas a day would not be 
enough to complete the contract for a 
great mass of merchandise by counting 
a great number of coins." There is plenty 
of evidence, however, that long before 
this date private bankers in Venice had 
been receiving deposits and using them 
in private ventures, but with such disas- 
trous results that in 1587 the State 
created an institution to take over the 

- 13 



The Goldsmith Becomes the Banker 

banking business of Venice and conduct 
it strictly as the custodian of money con- 
signed to its care. The Bank of Venice 
made no loans, and accepted no deposits 
but cash. 

The great banks of Amsterdam and 
Hamburg in the seventeenth and eigh- 
teenth centuries were of the same class; 
and the first deposit-banking in England, 
that of the goldsmiths, began in the same 
way. They had strong boxes for the pro- 
tection of their own valuables and con- 
sented to receive money for safe-keeping 
on a small charge. As experience showed 
that in the usual course of business with- 
drawals and deposits offset each other it 
became apparent that a considerable por- 
tion of the deposits might be loaned and 
made productive. This is where the gold- 
smith became a banker as we understand 
the term. His relation to the deposits 
underwent a radical change; instead of 
being the custodian he became the owner. 
He was in debt for them, but they were 
his, and, subject to the provisions he must 

14 



The Creation of Credit 



make for repayment, this hitherto dead 
capital became available for use. From 
being a mere convenience he became an 
active and independent factor in affairs. 

The change was of tremendous import- 
ance. It signified much more than the 
release of a given amount of coin for 
circulation. It created a vast fund of 
credit which used with moderation and 
understanding had all the potency of the 
highest form of capital. Credit is not a 
substitute for capital, but it is a most 
effective agency of capital. It is capital's 
other self, endowed with the powers of 
the principal but possessing an elasticity 
and mobility which the principal does not 
have. If it has been misused in ignorant 
hands with calamitous results that is no 
more than has happened with all the great 
forces and influences that contribute \o 
the progress of the world. 

The banks of the United States hold 
about $1,500,000,000 of money and they 
have approximately $15,000,000,000 of 
deposits and $12,000,000,000 of loans. If 

15 



The Banker, the Settling Agent 

they were doing business under the old 
plan, and could possibly gather up 
$1,500,000,000 of money, that would be 
exactly the amount of their deposits and 
their loaijs and discounts could not exceed 
their capital. It is impossible to conceive 
of the modern industrial and commercial 
organization without the modern system 
of banking. 

The banker, evolved from the gold- 
smith, was an intermediate species; he 
was primarily a dealer in money and 
incidentally a dealer in debts and credits. 
He received for the most part money and 
loaned money, for that was the custom of 
the time, but from him has been evolved 
the banker who deals primarily in debts 
and credits and only incidentally in 
money. 

The banker has become the bookkeeper 
and settling agent of the business world. 
The products of a locality, let us say the 
State of Georgia, move out to the mar- 
kets of the world and create credits in 
favor of that locality on the books of 



An Illustration 



banking institutions in the commercial 
centers, while at the same time a counter 
movement of commodities is under way 
from other localities into Georgia, in like 
manner creating credits for those locali- 
ties which are debits against Georgia. 
The practical effect is that the commodi- 
ties moving between these communities 
are exchanged and pay for themselves, 
the running accounts being kept and 
settlements effected in the banks. 

To illustrate the details: A dealer in 
cotton in Atlanta makes a sale to a mill 
in Fall River and receives in payment a 
cheque or draft drawn on a New York 
bank, which he deposits for the credit of 
his account in an Atlanta bank, and 
which the latter forwards for the credit 
of its bank account in New York. Mean- 
while an Atlanta merchant has bought 
goods in New York and in order to pay 
for them buys from the Atlanta bank an 
order for the New York credit, and this 
when forwarded completes the circle of 
payments for cotton and goods. 

17 



Bank Credit, Cheque and Draft 

If we would extend the investigation to 
include the bank accounts of the Fall 
River mill and the Atlanta dealer we 
would find, first, that the mill account was 
built up constantly by deposits of cheques 
and drafts received in payment for goods 
sold in all parts of the country and per- 
haps all over the world, with almost no 
deposits of cash, and that it was drawn 
down by cheques for raw cotton, and sup- 
plies and large amounts of cash for the 
pay-rolls; second, that the cotton dealer's 
account was built up entirely by deposits 
of cheques or drafts received for cotton 
shipments and drawn down by cheques 
and cash payments to farmers for cotton. 

For payments at a distance and for 
large payments everywhere, bank credit 
in the form of a cheque or draft is used; 
for wages, payments to farmers and the 
retail trade, money is commonly used, but 
the practice of keeping a bank account 
and making payment by cheque con- 
stantly grows and encroaches upon the 
use of money in those fields. Moreover, 

18 



Gold a Mere Token 



the "money" of retail transactions is usu- 
ally only another form of credit — bank 
notes, government paper, or metal coined 
at an artificial value. Money as a mere 
medium of purchase is no more than a 
token or ticket or order for a certain 
value ; even gold coin has no other signifi- 
cance in such use. We cannot do without 
gold as the measure of values, as the basis 
of our monetary sj^stem and as the money 
of international payments, but it is too 
costly to be used as a common instrument 
of retail trade. 

During the panic of 1907 an amusing 
story went the rounds, of an Irishman 
who called at a bank to draw his deposit. 
The cashier offered him a clearing-house 
cheque and explained that it would be 
accepted everywhere and serve all the 
purposes of money. The Irishman lis- 
tened attentively and said: "Yes, I 
understand; and if the baby at our house 
wakes up in the night and cries for milk 
I suppose I am to give him a milk ticket." 
We all laughed at the Irishman's wit, but 

19 



Trade Relations 



why ? A man doesn't want a government 
note or a gold coin in the same sense that 
he wants food. He wants money for the 
same reason that he wants a milk ticket, 
as a means of getting something else. 

The money which the banks supply to 
the Fall River mill and Atlanta dealer 
for pay-rolls and cotton purchases quickly 
finds its way into the tills of the town 
merchants and back into the banks to be 
used over again. If there was only one 
bank in a town and every payment from a 
car fare up was made by a ticket or note 
transferring credit in that bank, and there 
were no transactions with the outside 
world, and all tickets or notes were de- 
posited at the close of each day, it is evi- 
dent that the condition of the bank would 
be the same from day to day and the busi- 
ness of the community would "clear" 
itself. That is a microcosmic, though 
fore-shortened, picture of the trade rela- 
tions of the world. 

The banker setting up in business pays 
in a given amount of capital as a guaranty 

20 



The Banker and the Depositor 

of his own responsibility, establishes his 
connections in the principal commercial 
centers with which his community has re- 
lations, and invites customers. He re- 
ceives some idle hoards, some money from 
customers engaged in the retail trade and 
provides such part of his capital in money 
as he thinks prudent, but the bulk of the 
deposits that flow over his counter consist 
of instruments of exchange, which make 
him the owner of credits on the books of 
various other banks far and near. He 
gives the depositors credit on his own 
books in payment and undertakes to place 
credit at their disposal wherever ihey 
want it or to pay them the full amouii t in 
lawful money on demand. The latter is 
the perilous part of his undertaking, but 
the condition is peremptory. The effic- 
iency and usefulness of a banking system 
depend upon the absolute and certain 
fulfillment of this undertaking to pay 
cash on demand. A banking system must 
be so organized that its individual mem- 
bers can pay cash, i. e., lawful money, on 

21 



The Movement of Exchanges 

demand, and the public must have con- 
fidence in their ability to do this beyond 
the possibility of failure, or the system is 
not fit for the vast responsibilities that 
devolve upon it. The task of gathering 
together the scattered credits which are 
daily assigned to him and of furnishing 
his customers with the credits they want 
at distant points is not difficult. Of one 
hundred men who come into the bank per- 
haps fifty will want to deposit drafts on 
distant cities and the other fifty will want 
to buy drafts on the same or other cities ; 
he sells the latter what they want, trans- 
fers the deposited credits to meet them, 
and closes the day's business in practically 
the same condition as before. 

The foregoing illustrates the move- 
ment of the exchanges constantly pro- 
ceeding not only between the different 
communities of one country but between 
the communities of different countries. 
There is a network of relationship be- 
tween banks through which each local 
community and market is connected with 

22 



Payments Resolved Into Offsets 

all other communities and markets in the 
world. No locality is so remote as to be 
outside of the circle and no community's 
sales and purchases are so scattered but 
that they can be brought together in the 
settlements. Each bank is the center of 
a circle of which it is the clearing agent; 
all payments between its own customers 
may be made by a transfer of credit upon 
its books. If there are two banks or more 
banks in a town, all payments between 
their customers are resolved into offsets 
between these banks, and in like manner 
all payments between localities are re- 
solved into offsets between banks, and if 
not settled in local centers are passed up 
to larger and larger clearing centers until 
they reach New York for this country or 
London, the recognized clearing center 
of the world. 

But while the cross-payments of trade 
may be depended upon in the long run to 
balance and settle themselves, it does not 
follow that they will do so from day to 
day, or that they coincide so closely that 

23 



Trade by Districts 



payments in money are never required. 
An individual's sales and purchases are 
seldom made at the same time, and the 
sales and purchases of communities are 
not constantly balanced. The trade of a 
one-crop farming district will not be so 
evenly balanced as one of a district in 
which mixed farming prevails, and in 
every industry there are periods, usually 
recurring every year, when the payments 
exceed the current income, and corre- 
sponding periods when income exceeds 
outgo. This means in the case of the in- 
dividual that at one time he is building 
up his credit balance with his banker 
and at another time drawing it down, 
and, unless he has more capital in his 
business than he can employ constantly, 
he will be wanting to borrow credit. And 
so a region like the cotton states, 
whose products move quickly to market, 
may have large credit balances at one sea- 
son and at another be wanting to borrow. 
In fact, these fluctuations are always 
occurring and they furnish the banker his 

24 



The Purchasing Power 



opportunity for profit. The banker is an 
equalizing agency in the situation. He 
stands in the breach: he must either sup- 
ply the missing offsets of credit, or, as a 
last resort make the payments in money. 
We have seen that if the exchanges are 
running in favor of an individual because 
he is temporarily receiving more than his 
average of payments he will necessarily 
be piling up a credit balance with his 
banker, thus supplying the latter with 
lending power to aid some one who is a 
debtor in the exchanges. If a farmer 
sells his crop and receives his year's in- 
come at once in shape of a bank credit, 
he has the privilege of drawing upon it 
until it is exhausted, but the fact that he 
will receive no more for a year practically 
compels him to make it last throughout 
that time. Meanwhile the purchasing 
power of his crop is in the hands of the 
bank and may be loaned under conditions 
that will secure its return as fast as the 
farmer, or the average of a hundred such 
depositors, will call for it. Evidently the 

25 



The Limitation of Credit 



fact that the farmer accepts the bank's 
credit as cash, although he will actually 
use it in installments throughout the year, 
has served to spread the purchase and 
distribution of the crop over the year. 
And for this use of the bank's credit the 
borrower pays interest. He might have 
made an arrangement to buy the crop of 
the farmer direct and pay in installments, 
but the farmer prefers a closed transac- 
tion and a credit in bank subject to 
cheque. 

Not only has the banker the power to 
loan the credits which his customers have 
transferred to him, but he has the right 
to create new credits for his customers in 
exchange for their notes, thus expanding 
the total volume of credit. This power 
gives an elasticity to banking facilities 
which they would not otherwise possess. 
The only limitation upon this creation of 
credit, or purchasing power, is the ever- 
present requirement that all casli credits 
must be liquidated in lawful money on 
demand. This possible demand for cash 

26 



Reciprocity of Trade 



in uncertain amounts is the sword of 
Damocles that hangs over the banker's 
head. 

The entire system of settlements, with 
transfers and offsets and advances and 
interchange of capital and credit, is ex- 
ceedingly interesting and wonderfully 
simple and effective, but depends for its 
effectiveness upon a scrupulous observ- 
ance of the principle upon which it is 
based. That principle is the natural 
reciprocity of trade. If one set of custom- 
ers are for a time receiving payments in 
excess of the average due them and thus 
piling up balances that may be tempor- 
arily used the banker is bound to remem- 
ber that later these customers must receive 
less than their average and will not only 
need to use the credit that is due them 
but be borrowers in their turn. These 
inflexible conditions circumscribe the 
banker and dictate the character of the 
loans he may make. Credit should never 
be a substitute for capital, at least not in 
the banking business ; it should always be 

27 



Use of Credit 



the representative of capital and never 
get far from its principal. The credit 
used in the exchanges should be based 
upon capital employed in the exchanges, 
with constant liquidation and interchange 
of the two. The idle credit upon the 
books of the bank today may be used to 
move wheat to market or to weave cotton 
into cloth, in confidence that in a few 
weeks or months at the latest this prop- 
erty will be converted back into credit and 
be available for use elsewhere. It cannot 
be safely used for the construction of a 
building or the purchase of machinery, 
howxver satisfactory the annual returns 
from such investments may be, because 
the nature of the property gives no assur- 
ance as to when the principal will be re- 
turned. 

It is not strange that with banking an 
open and competitive business, these 
essential conditions should not always be 
observed and that occasionally a banker 
should fail in the supreme test — ability to 
meet all demands in cash. And as Credit. 

28 



Sensitiveness of Credit 



with all the potency that it borrows from 
Capital, is itself an intangible thing, mere 
opinion, that a whisper may destroy, with 
the interdependence that exists between 
bankers and between bankers and cus- 
tomers, such failures may easily have far- 
reaching and disastrous effects. The very 
economies of the system, the manner in 
which each man's credit and capital are 
merged in the common fund in order that 
all our productive powers ma)^ be com- 
pletely employed, are responsible for an 
all-pervading sensitiveness, which is the 
most serious weakness of the system. The 
moment apprehension becomes general 
the effectiveness of the system is de- 
stroyed. 

While there are balances from time to 
time in the exchanges between countries, 
and between different localities of the 
same country, which cannot be settled 
without shipments of money, they are 
usually met without inconvenience unless 
there is a disturbance of credit. All de- 
mands but those arising from alarm about 

29 



The Movement of Crops 



credits can be estimated, and credit can be 
more or less used in meeting them, the 
adjustment in such cases being chiefly a 
question of the price to be paid for what- 
ever accommodations are wanted. In 
some instances, however, the facilities or 
restrictions of the banking system in 
respect to the use of the various forms of 
credit determine whether money must be 
moved or not. 

The movement of the crops each year 
in the United States requires an import- 
ant movement of money from the centers 
to the agricultural districts, but this is not 
so much in settlement of a trade balance 
as to provide a medium of making pay- 
ments to farmers. As they adopt the 
custom of keeping bank accounts and giv- 
ing and receiving cheques this demand 
for money will decline, or if w T e had a 
scientific bank note system it could be met 
with that form of bank credit. 

A crop failure may deprive a locality 
of the usual supply of commodities upon 
which it depends to make good its side 

30 



A Crop Failure 



of the exchanges. Its buying, although 
possibly restricted, goes on, and eventu- 
ally the balances must be made good by 
the sale of property or the negotiation of 
outside loans, or the bankers must ship 
out money. A few years ago the south- 
western states of this country suffered 
from a severe drought. The crops were 
a partial failure and the usual shipments 
could not be made. Moreover it was neces- 
sary to ship grain in to feed the stock on 
the farms. The balances were naturally 
against the bankers of that section. The 
forehanded farmer who had a credit bal- 
ance at the bank had a right to draw on 
it to buy grain, and it was for the bank to 
find the means of meeting the draft. It 
could call on the farmers who were its 
debtors to ship their stock or any other 
movable property, to market, or to mort- 
gage their farms to outside loan compan- 
ies if they were not already mortgaged, 
or it could borrow of an outside corre- 
spondent on its own credit, or after ex- 
hausting its cash reserves it could close 

31 



Impairment of Credit 



its doors and wind up business ; and all of 
these things were done. Some method by 
which an outside supply of credit could 
be made available to the local banks 
would tide such a community over its 
emergency. 

In the several years immediately pre- 
ceding 1897 the agitation over our stand- 
ard of value created alarm among foreign 
holders of our securities and caused the 
latter to be sent home in large quantities, 
thus creating adverse balances for us and 
forcing the shipment of gold in settle- 
ment. In that case we could not inter- 
pose our credit to stop the drain, for it 
was the impairment of our credit that was 
causing the movement. 

One of the most notable movements of 
gold that ever occurred was that from 
London and the continent of Europe to 
the United States in the last two months 
of 1907. Conditions in Europe through- 
out the year had been such that the banks 
were reluctant to lose gold, and had raised 
every possible obstacle to its going, but in 

32 



$100,000,000 in Gold Imports 

November a combination of circumstances 
made all opposition useless. The crop 
movement in the United States was on 
and European buyers wanted the com- 
modities. The panic in this country put 
such pressure on the banks for cash that 
they used pressure to hasten the crop for- 
ward; the demoralization in trade result- 
ing from the panic was so great that im- 
porters cancelled many of their foreign 
orders for goods. The security markets 
of this country were so low that European 
investors improved the opportunity to 
buy heavily of our stocks; and, finally, 
the suspension of cash payments created 
a premium upon money which furnished 
an additional incentive to import gold. 
Altogether the forces were irresistible 
and over $100,000,000 in gold was trans- 
ferred to this country. Here again it is 
to be noted that the conditions were ab- 
normal and due primarily to a break- 
down of credit, and that this break- 
down occurred not in the countries from 
which the gold was moving but in the 

33 



Integrity of Credit 



country to which it was taken. The oper- 
ations of our banking system were inter- 
rupted by panic and the only means of 
restoring confidence and order was by the 
importation of gold. 

It will be seen that practically the only 
interruptions that occur in the regular 
and satisfactory flow of the exchanges 
through the banks, or to the performance 
of any of the banking functions upon 
which the business community has learned 
to rely, have been due to apprehensions 
about the integrity of credit. These ap- 
prehensions relate at first to only a few 
banking institutions but spread until all 
are directly or indirectly affected, and re- 
gardless of whether there is basis for sus- 
picions or not. Experience has shown 
that the problem of preventing these dis- 
turbances is largely a question of bring- 
ing some higher or better known credit to 
the support of the particular factor which 
is threatened. How this may be effect- 
ually done will be considered later. 

A simple statement of the functions of 

34 



The Problem 



banking should be sufficient to convince 
every one that they are useful, legitimate 
and indispensable, and based upon prin- 
ciples fundamentally sound. The bank- 
ing business does not sit at the cross-roads 
of the exchanges to take toll by any 
legerdemain, or by any privilege or mon- 
opoly, or in any sense as a non-producer. 
Its services are as distinct and creative 
as those of any industry and the benefits 
are distributed to all the consumers of the 
commodities handled by the exchanges. 
It is a business that never can be a mon- 
opoly, for it controls no natural resource 
or opportunity ; its earnings are from cur- 
rent business and its customers are 
alternately debtors and creditors and 
must be satisfied in both relationships or 
they can easily form new connections. 

The problem of perfecting the bank- 
ing system to enable these functions to 
be performed with greater economy, 
efficiency and certainty is not a problem 
of helping bankers but of perfecting the 
organization of society. 

35 



STORY OF NATIONAL BANKS 



Two considerations of great impor- 
tance were named by the Secretary of the 
Treasury, Salmon P. Chase, in his origi- 
nal proposal for a national banking sys- 
tem, submitted to Congress December 
9, 1861. One was to provide the country 
with a national currency, secured as to 
redemption by the bonds of the Govern- 
ment itself, which would circulate at a 
uniform value in all sections; the 
other was to create a new demand 
for the bonds which the necessities 
of the Civil War were compelling the 
Government to offer in large amounts, 
and on which up to that date, the net in- 
terest charge was more than six per cent, 
per annum. The men who designed the 
National Banking system of the United 
States tried to serve two masters. The 
result has its unfortunate side. They 
tried to serve the people by designing 

36 



Fundamental Errors 



what they hoped would be a sound, well- 
guarded, effective banking system. At 
the same time they tried to serve the Gov- 
ernment by creating a fictitious market 
for a vast amount of Government bonds. 
It may be well within probability that the 
fundamental errors contained in the 
banking act in the half century during 
which they have hampered our domestic 
development and fettered our advance to 
the position we are entitled to occupy in 
world finance, have cost the people of this 
country as much in dollars as did the war 
that gave rise to those legislative errors. 
The cost of a bad banking system, in a 
nation of such vast and active commercial 
resources as ours, is really incalculable. 
We have through most of our history 
grown commercially in spite of bad bank- 
ing laws. Unresponsive and inadequate 
as our banking act is, it still was a great 
improvement over the bad legislation that 
had created most of the State banking 
systems in the period of complicated un- 
soundness and inadequacy that pre- 

37 



Need of Reform 



ceded the enactment of the National 
Bank Act. 

The common currency of the country 
at that time was State bank notes, the 
value of which, as the Secretary of the 
Treasury said, was "dependent upon the 
laws of thirty-six States, and the char- 
acter of some sixteen hundred private 
corporations." So far as the proposal had 
in view the improvement of banking con- 
ditions it related almost exclusively to 
regulation of bank note currency, and so 
great was the need for reform in this re- 
spect that Alphonso Taft, of Cincinnati, 
father of President William Howard 
Taft, writing to Secretary Chase two 
days after the report was published, ex- 
pressed the opinion that "if Congress 
would adopt his recommendations for a 
national currency that in itself would be 
no inconsiderable compensation for the 
War." 

Prior to the establishment of the na- 
tional banking system the bank note was 
the most familiar form of bank credit in 

38 



The Circulating Note 



the United States, as it still is in many 
countries today. The first extensive use 
of bank credit everywhere was in the form 
of circulating notes; the chequing ac- 
count, which has become so common w T ith 
us, being a later development. There 
were various reasons, in the earlier de- 
velopment of banking facilities, why the 
note should be preferred. The individual 
would find bank notes more generally ac- 
ceptable than his private cheque. The 
bank's credit was more widely known 
than his own. Comparatively few people 
had bank accounts and people preferred 
to receive payment in something that 
could be paid out directly without incon- 
venience. The bank note was a means of 
extending the use of bank credit to a 
large class of people who otherwise would 
not employ it at all. A bank accepted 
the note of a customer, w T ith such security 
as it might exact, and gave in return its 
own notes payable in coin on demand and 
printed in denominations convenient for 
use as monev. The borrower made his 

39 



Bank of England Notes 



payments with these and the recipient, 
instead of presenting them for redemp- 
tion, likewise paid them out as money, 
and so they were passed on from hand 
to hand as a substitute for coin. Upon 
a given amount of coin reserves it was 
possible to keep in circulation a much 
larger amount of notes. The excess rep- 
resented bank credit doing the w r ork of 
capital. 

It is significant of banking practice at 
the time the Bank of England was 
founded that its promoters thought they 
had secured a practical monopoly of the 
business by a provision in the charter 
which forbade any other company of six 
members or more to issue promissory 
notes payable on demand. It was not 
until 1833 that the first corporation was 
organized in England to do a deposit and 
discount business without the currencv 
accompaniment. Up to that time it had 
not appeared practicable to use cheques in- 
stead of bank notes in common transac- 
tions. It was the restriction placed upon 

40 



Character of a Bank Note 

note issues in England in 1844 and in this 
country by the National Bank Act which 
developed the use of the cheque in these 
countries so far beyond its use elsewhere. 
In France, Germany, and the other coun- 
tries of Europe, to the present time, the 
bank note is still the popular medium of 
payment. 

The National Bank Act, as we shall 
see, effected a radical change in the char- 
acter of the bank note. The currency 
privilege had been so abominably abused 
under many of the old State bank sys- 
tems that the true function of a bank cur- 
rency has been almost totally obscured in 
this country. The bank note in its ideal 
capacity belongs in a class with the bank 
cheque and the bank draft, as a free, un- 
fettered instrument for transferring bank 
credit. The National Bank Act put it 
practically in a class with the government 
note, as a fixed form of currency. In do- 
ing that there was a fundamental failure 
to grasp the true function of the bank 
note. 

41 



Bank Notes and Cheques 



The bank note is the natural comple- 
ment of the cheque in deposit banking. It 
enables a bank or banking system readily 
to convert deposits into circulating notes, 
and thus furnish the community with 
currency by simply changing the form of 
its obligations, and in perfect response to 
the community's needs. Let us take for 
an illustration the case of a manufacturer, 
who sells his goods at wholesale and re- 
ceives practically his entire income in 
cheques and drafts, for which he receives 
credit in his bank account. He pays for 
his supplies usually by drawing cheques 
on that account. But when it comes to 
his pay-roll that method is not satisfac- 
tory because the wage-earner objects to 
taking the time and trouble during bank- 
ing hours to get these cheques cashed. The 
employer accordingly calls upon the 
banker for money for the pay-rolls. He 
draws a cheque for the full amount and the 
banker, if permitted by law to do so, 
would supply the sum in the bank's own 
notes. This simply changes the form of 

42 



Convenience of the Bank Note 

the bank's obligation from a deposit 
promise to a note promise. The wage- 
earners receive these notes, pay them out 
to merchants, landlords and others, with 
net result that, within a few days, most 
of them reappear at the bank as deposits. 
The bank is now in the position it was 
before the notes were issued except that 
a certain amount of credit has been trans- 
ferred from the manufacturer's account 
to the accounts of sundry other depositors. 
In no other conceivable way can this class 
of payments be so easily and economi- 
cally handled. They are typical of local 
payments generally. The notes repre- 
sent no investment while they are idle in 
the banker's safe. While they are out- 
standing adequate reserve of coin is kept 
against them. The instant they return 
to the bank they cease to be a charge. 

Compare this with the use of gold coin 
for the pay-rolls ; the coin makes the same 
rounds and renders no better service. 
But, at every stage of its existence, 
whether in a banker's vault or in circula- 

43 



Three Forms of Bank Credit 

tion, coin represents an investment at its 
face value. The interest on that invest- 
ment is a constant charge on the ex- 
changes. 

It is evident also that there is a perfect 
adjustment of the volume of such a bank 
currency to the calls of the community for 
cash. 

The notes are interchangeable with the 
deposit credits in any amount without dis- 
turbance. The public is able to use per- 
sonal cheques, bank currency or bank 
drafts, as best suits the kind of payments 
to be made. The three forms of bank 
credit cover every variety of payment in 
domestic trade. They are all of the same 
species and together make a complete set 
of instruments for the transfer of credit, 
in a system the essential principle of 
which is that such credits, when brought 
together in the clearing-houses, will bal- 
ance and settle themselves. 

Experience has shown, however, that 
while a bank's liability is the same whether 
a customer takes his credit in the form of 

44 



Restrictions on Bank Note Issues 

a deposit subject to cheque or in the bank's 
own circulating notes, there is more 
danger of abuse in the latter method of 
creating credit than in the former. The 
reason is that the note liability is some- 
what obscured by the use of the notes as 
a common currency; the notes are scat- 
tered far and wide, often by design, and 
nobody is sufficiently interested in send- 
ing them home for redemption to make 
that an effective check upon overissues. 
On the other hand a cheque drawn upon a 
deposit account, appears immediately at 
the counter of the bank and, if not com- 
pletely effective in preventing undue ex- 
pansion, is an influence to that end. 

The world's experience with bank cur- 
rency, therefore, while demonstrating 
that it has a function in the exchanges 
that no other form of credit, not even 
standard money, can perform, has caused 
nearly all countries to place restrictions 
upon it. In most of them the power of is- 
sue is now confined to a single institution 
and exercised under close governmental 

45 



A Market for Bonds 



supervision, this institution being charged 
with the responsibility of maintaining an 
adequate gold reserve and supplying all 
the banks with currency as they need it. 
The elasticity of the currency is thus in 
a large degree preserved while effective 
safeguards are placed about its issue. 

The movement in the United States to 
restrict and control bank currency was 
a part of a world-wide movement. But 
in this country the resulting system was 
shaped by influences that did not exist 
elsewhere. The purposes held by the 
founders of the national banking system 
were realized. It created a market for 
large amounts of government bonds and 
eventually made possible a reduction of 
the interest on the public debt to the low- 
est rate ever reached in any country upon 
any class of securities. It gave us a truly 
national currency, every note good with- 
out question or discount in every part of 
the country. These were very great and 
perfectly obvious benefits. The superior- 
ity of the new currency was especially ap- 

46 



Currency Must Be Safe and Efficient 

predated by the public, for the defects 
of the old system were a daily vexation to 
everybody. Naturally the national sys- 
tem, compared with what had preceded 
it, became firmly established in the con- 
fidence of the country. 

Now, of course it is of the first im- 
portance that a currency shall be safe. 
But it is of scarcely less importance that 
it shall be efficient for the particular ser- 
vice it is expected to perform. The 
trouble with the national banking system 
is that its authors were so intent upon 
other aims that they lost sight of the es- 
sential function of a bank currency, 
which is to supply an elastic element in 
the monetary stock. 

The fundamental question in dealing 
with currency is whether or not there 
is any natural relation between cur- 
rency and banking. One of the results 
of the movement to restrict bank issues 
was the development of a considerable 
body of opinion in support of the idea 
that banking should be confined strictly 

47 



Government Notes vs. Bank Notes 

to receiving deposits and making loans; 
that it should have nothing to do with is- 
suing currency. In England this view 
became strong enough to change the con- 
stitution of the Bank of England, but its 
advocates there contended only that the 
banks should do business with gold or 
notes that represented an equal amount 
of gold. In this country the idea was 
greatly encouraged by the issue of United 
States notes in the form of currency. In 
the light of this example there developed 
a party which argued that the issue of 
money, or anything that had the sem- 
blance of money, was an act of sovereign- 
ty; that government notes should take 
the place of all bank notes. One of the 
most distinguished opponents of a bank 
note currency responding to an opinion 
that the government should retire the 
legal- tender notes and "get out of the 
banking business," epitomized the opposi- 
tion by retorting that the banks should 
retire their currency notes and "get out 
of the government business." Here then 

48 



Government Must Fix Standard of Value 

is the vital and debatable point in the cur- 
rency discussion. Is there such a neces- 
sary relationship or mutual interdepen- 
dence between the functions of banking 
and the functions of a currency system 
that the two sets of functions must be co- 
ordinated in order that either may be suc- 
cessfully performed? That is precisely 
the contention of those who believe in an 
elastic bank currency. 

There is no real issue over the question 
of "sovereignty" in this connection. Un- 
questionably the government must fix the 
standard of value and determine what 
shall be legal-tender, and nothing else is 
real money. 

It is agreed also that the government 
should regulate and supervise all forms 
of private or corporate credit designed 
for use as currency, in order to enforce 
its redemption in gold on demand. Here, 
however, we approach the limits, not per- 
haps of the government's authority, but 
certainly of its ability to perform the 
function of supplying currency in the 

49 



Demands on the Banks 



volume, at the time, and in the place, 
required by the changing conditions that 
affect the business world. 

Neither the government officials who 
come and go at Washington, nor any 
other authority, can determine in advance 
how much currency will be required from 
time to time. Nobody knows how much 
currency the people of this country will 
call for next year or even next month. 
Nobody can tell within hundreds of mil- 
lions of dollars what the crops of the 
country will be worth, or what the volume 
of trade will be next year, or how much 
of that business will be handled by means 
of cheques and drafts and how much will 
require currency; nor can any one tell 
what part of the $16,000,000,000 of bank 
deposits in the United States may be 
called for in cash at any time. All of these 
demands are uncertain and fluctuating. 
They are directed, not to the Govern- 
ment, not to the offices of the Treasury, 
but to the banks. Not until the Govern- 
ment receives deposits and makes loans 

50 



Banks to Pay on Demand 



and enters upon all the functions of bank- 
ing, will it be in position to measure the 
demand for currency or to supply it di- 
rect. Until then, wherever the authority 
for issue may be lodged, all supplies must 
reach the public through the banks. 

On the other hand, the banks are ex- 
pected to supply currency to meet all the 
fluctuating demands of trade. They are 
required to pay lawful money or a cur- 
rency acceptable in its stead for all their 
deposit liabilities on demand, or confess 
insolvency. Is there no relationship be- 
tween this obligation and the function 
which would enable them to meet it? 

The volume of currency cannot be re- 
sponsive to the needs of trade unless it 
may be based upon the credit of the 
traders who use it, backed of course, by 
the commodities which are moving. If 
wanted to move grain it must be based 
upon the credit of the dealer and the value 
of the grain, and if wanted for merchants 
or manufacturers it must be based upon 
their credit and their goods and materials 

51 



National Bank Notes 



in stock. Neither a grain dealer nor mer- 
chant can give government bonds as se- 
curity unless he is something more than 
a grain-dealer or merchant; nor can the 
banker who supplies him with credit give 
bonds as security unless he is something 
more than a banker. The banker has no 
security to offer except what he receives 
from his customers, and there can be no 
elasticity in the currency, or certainty 
that a banking system will meet its obli- 
gations, or sure basis for public confi- 
dence in time of strain, unless currency 
can be created upon banking assets. 

The requirement that national bank 
notes shall be secured by government 
bonds takes them out of the class of re- 
sponsive currencies. The volume of these 
notes is determined by conditions utterly 
foreign to the conditions of trade. There 
is no connection or relationship between 
the amount of currency a country needs 
and the amount of its public debt. It has 
frequently happened that a period of na- 
tional prosperity and large revenues has 



Restriction on Bank Currency 



caused a reduction of the public debt at 
the very time when a larger volume of 
currency was required. On the other 
hand a great war might cause an increase 
in the debt that would make the currency 
privilege a menace to our monetary sys- 
tem. 

This arbitrary restriction upon bank 
currency has compelled the banks of this 
country to do business without any ele- 
ment in the monetary stock that was read- 
ily adaptable to the varying demands 
upon them for currency. The trade of 
the country fluctuates from time to time, 
reaching its greatest activity each year 
during the autumn months. The princi- 
pal crops are then being moved to mar- 
ket ; farmers demand cash, particularly in 
the case of cotton, which moves rapidly. 
Large sums of currency, therefore, must 
be withdrawn from the banks of the cen- 
tral cities. It is a matter of indifference 
to the farmer whether the currency he 
needs in the crop moving operation is in 
the form of a secure bank note or in money 

53 



Need of Money in the Fall 

that might be the basis of a bank's cash 
reserve. But it is a matter of the most 
vital importance to the community served 
by the bank whether or not it can per- 
form this service by parting with its credit 
or whether it must invade its cash reserves 
and consequently shrink the whole credit 
structure which stands on that stock of 
reserve money. The fall of the year is 
the period of heaviest retail trade. The 
money withdrawn from the banks passes 
to the farmers and thence from hand to 
hand discharging local obligations, event- 
ually reaching the local banks and ulti- 
mately finding its way back to the centers 
after the holidays. Clearly the country 
needs a great deal more money during the 
fall months than at any other season, but 
the supply does not adjust itself to this 
condition unless the pressure is great 
enough to force the importation of gold. 

There are several reasons why gold 
does not move readily enough to supply 
the desired elasticity in our monetary 
stock. In the first place our command 

54 



Gold Not Available 



over gold depends upon numerous con- 
ditions that are beyond our control, such 
as the balance of trade, movement of se- 
curities, state of foreign trade and mar- 
kets, and the attitude of foreign bankers. 
The season of active trade with us coin- 
cides closely with the season of activity in 
Europe, so that we want more money at 
the same time they do. Furthermore, if 
we want it because financial conditions are 
threatening, the markets of the world are 
now so closely related that the foreign 
banker will cling to it for the same rea- 
son. When in 1907 we finally broke 
down all barriers and drew away from 
Europe heavy supplies of gold, great 
sacrifices were necessary to accomplish it. 
Finally, the cost of transporting gold 
across the ocean and back again in a few 
weeks, with the loss of interest while in 
transit, is a heavy charge for a temporary 
use. The result of these conditions is 
that this country usually experiences a 
sharp stringency in the autumn months. 
Neither money nor credit is available to 

55 



Lack of Unity 



handle the business of the country to the 
best advantage. The banks encroach 
upon their reserves, advance the interest 
rate to discourage the demand for loans 
and curtail accommodations as closely as 
possible. The business public neglects 
cash discounts, puts creditors off with 
promises and adjusts itself as best it can 
to a situation which always involves more 
or less stress, sacrifice and danger. 

It is often said in criticism of the bank- 
ers that as these conditions are repeated 
annually they should provide for them by 
entering the active season with larger re- 
serves. The individual banker, however, 
has but little influence upon the situation. 
He is controlled by competitive condi- 
tions. There can be no unity of purpose 
or common policy as the system is now 
constituted. Moreover, there is some- 
thing obviously wrong in the proposal 
that large sums of capital shall be kept 
idle during eight months of the year in 
order that they may be used as common 
retail currency during the other four 

56 



In Periods of Panic 



months. If the large transactions of the 
business world are settled with bank credit 
it ought to be possible to finance the local 
trade without passing gold from hand to 
hand. 

But the climax of the system's incapac- 
ity and helplessness is seen in the recur- 
ring periods of panic when practically the 
entire banking service of the country con- 
fesses its inability to meet the universal 
test of bank solvency, to wit : the payment 
of cash on demand. 

Although panics never disturb the 
credit of national bank notes the national 
banking system has not been able to pro- 
tect itself, or the public against these dis- 
asters. Its $700,000,000 of outstanding 
notes are secured but its $7,000,000,000 
of deposits, practically all payable on de- 
mand, are not only unsecured, they are 
unsupported by any system providing for 
their ready liquidation. The wisdom of 
the ostrich which sticks its head in the 
sand at the approach of danger has its 
parallel in the fancied security of the na- 

5? 



Cash and Credit Figures 



tional banking system because its notes 
are protected. 

Even this statement does not disclose 
the entire situation. In addition to the 
$7,000,000,000 of deposits in national 
banks there are $9,000,000,000 of deposits 
in banks operating under state charters. 
That means, in all approximately $16,- 
000,000,000 of bank credit dependent 
upon the responsibility of 23,000 banks 
(scattered over 51 States and Territor- 
ies) and upon popular confidence in their 
individual ability to pay cash on demand. 
Clearly there is no lack of material for 
panics to work on, although the national 
bank notes are secured. When in addi- 
tion it is remembered that the total 
amount of cash, held by the banks against 
these deposits, is less than $1,500,000,000, 
and that the total stock of money in the 
United States is estimated at less than 
$3,500,000,000, half of it being gold, 
there is no mystery about why we have 
bank panics while other countries do not. 
In all other countries the banks have the 

58 



Public Confidence 



power to use their ordinary assets as a 
basis for currency. Even the Bank of 
England, notwithstanding the Peel Act, 
in an emergency is allowed to do this. It 
has repeatedly suspended the bank charter 
to do it, and the assurance that it will do 
so, when necessary, is as effective as a 
statute. 

A simple statement of these facts is 
sufficient to expose the weakness of our 
banking situation. Public confidence, to 
be as stable and unquestioning as it is 
abroad, must have the same basis it has 
there, to-wit, a knowledge that the banks 
are equipped to meet any demands that 
may possibly come upon them. It 
is common knowledge that our banks are 
not. They have no means of defending 
themselves or of demonstrating their 
solvency. 

The inherent weakness of the banking 
situation in this country lies in the fact 
that it includes so many — 23,000 or more 
— independent and unrelated institutions 
competing actively with each other and, 

59 



Responsiveness to Local Conditions 

except for the degree of unlegalized co- 
operation developed in the Clearing- 
House Associations, without any coherent 
organization or leadership. It is apparent 
that the situation is radically different 
with regard to the practicability of volun- 
tary co-operation and mutual support 
than it is, for example, in the British 
Isles, where there are less than 200 bank- 
ing corporations with over 8,000 branch 
offices. It is probably true that our 
numerous banks, owned and managed in 
the communities where they are located, 
are less rigid in their rules of business and 
more responsive to local wants than the 
branch offices of large outside corpora- 
tions would be. On the other hand, there 
is the danger that this responsiveness 
everywhere to local conditions may be 
without proper regard for general condi- 
tions which may be all important; that 
the banking situation as a whole suffers 
for want of the larger view. It is also 
true that with so many individual units 
in the system there cannot possibly be as 

60 



Isolated Institutions a Menace 

high an average of experience and ability 
in the management as will be found, for 
example, in the twenty-nine banking 
corporations of Canada. 

This system of independent local banks 
has its advantages and is undoubtedly 
permanent in the United States. But 
without some organized means of co-op- 
eration and mutual support these isolated 
institutions are not only helpless in time 
of danger, they are a menace to each 
other. Some of them are certain to be 
imprudently or dishonestly managed and, 
under pressure, will succumb. 

Every failure at a time when credit is 
known to be under strain creates more 
distrust. The pressure upon others, un- 
prepared to bear it, increases. The alarm 
heightens and spreads until the entire sys- 
tem is prostrate. 

But the most disastrous effects and the 
most striking evidence of the constitu- 
tional weakness of the system are seen in 
the struggles of the individual banks to 
protect themselves at the expense of each 

61 



In Panic Times 



other in every emergency when their 
strength should be united. The banks 
lead in a scramble for cash which cannot 
possibly strengthen the situation as a 
whole. In fact, it actually hurries on the 
crisis. At the very time when it is of the 
highest importance to support credit in- 
dividual bankers curtail credit by the 
most drastic methods. And just when 
it is of the highest importance that the 
limited supply of money shall circulate 
with the greatest possible rapidity they 
seize every dollar within reach and lock it 
up. In short, the efforts which each bank 
will naturally make for self-protection in 
time of panic, and for the most of them 
the only efforts they can make, are such 
as must intensify the general alarm. 

A banking system should be a source 
of strength and support to the business 
community in times of financial strain. 
It is a recognized principle of banking 
that in a time of panic, when credit 
throughout the community is shaken, the 
banks should show the utmost liberality 

62 



The Steadying Influence 



in extending credit to all who are entitled 
to have it. There is no limit to which de- 
moralization may not go in the excite- 
ment of general alarm, unless solvent 
houses may obtain their usual accommo- 
dations. On the other hand, the steady- 
ing influence in every crisis is the buying 
power of people who have credit in re- 
serve and are influenced by the unusual 
conditions to come into the market and 
use it. The banking system is the organ- 
ization through which these reserve 
powers are exercised. When that organ- 
ization breaks down or refuses to perform 
its usual function demoralization is com- 
plete. Nothing could be more unfortu- 
nate when alarm prevails and reaction is 
under way than for the banks to be forc- 
ing the collection of loans in order to 
make a showing of individual strength or 
for the purpose of liquidating deposits, 
There should be some other means of sat- 
isfying the anxieties of depositors than by 
prostrating the business community to do 
it. 

63 



Importance of Protecting Bank Credit. 

We have seen that bank credit is a 
factor of constantly increasing impor- 
tance in the business world. The neces- 
sity for a metallic basis for that credit is 
not in dispute, but the credit transfers 
through the Clearing-Houses of 100 cities 
in 1910 were one hundred times the total 
stock of gold in the country. The trade 
of the world is settled through the banks 
in reliance upon their solvency; industry 
and commerce are financed upon bank 
credit to such an extent that the orderly 
course of business is dependent upon its 
stability. Always excepting the integrity 
of the standard of value itself, there is 
nothing so vital to the business commun- 
ity as that this vast fabric of credit shall 
be properly supported. 

The importance of protecting bank 
credit in the form of bank notes has long 
been recognized, but in the development 
of banking in the United States since the 
national system was established, the book 
liabilities of the banks, from being less 
than the note liabilities, have become 
twenty times the note liabilities. It used to 

64 



Deposits Payable in Cash. 

be argued that bank notes were a form of 
credit which should be especially guarded 
because they were a common currency and 
the means by which wages were paid. 
Without qualifying in the slightest the 
demand for a safe currency it should be 
added that there is no darker day for the 
wage-earner than when the banks sus- 
pend the payment of deposits and begin 
a hurried collection of loans. The amount 
of currency he has in his pocket is not 
more important to him than regular em- 
ployment. A persistent demand for the 
withdrawal of deposits in cash means that 
the entire system by which industry and 
commerce is supported is going to pieces. 
It is a fundamental condition of bank- 
ing that a bank shall pay cash on demand. 
It is this condition that makes bank credit 
the highest and most available form of 
credit. If a single bank fails to meet this 
test its doors close in ruin and disgrace. 
Yet the entire banking system of this 
country may be forced to suspend pay- 
ment, with inestimable confusion and in- 
jury to all business interests, because no 

65 



The Highest Fonn of Credit. 

system exists for creating an acceptable 
currency upon bank assets. 

It is not to be supposed that the coun- 
try will go back to unrestricted note is- 
sues based upon the individual responsi- 
bility of 23,000 or even 7,000 banks; it is 
impossible for such a division of responsi- 
bility to command unwavering confidence. 
But nobody ever believes that any con- 
siderable proportion of these banks are 
insolvent and it is safe to say that to 
whatever extent they pledge their credit 
together it will be unquestioned. The 
problem of banking reform is to provide 
a higher form of credit that can be 
quickly substituted for any particular 
credit that is threatened. The highest 
possible form of credit, readily available 
in any sum required, is a bank note cur- 
rency based upon the united assets of a 
national system. When each individual 
bank in the system can depend upon se- 
curing currency of this kind, to the ex- 
tent of its own approved assets, bank 
credit in the United States will be safe 
from any general panic. 

66 



SAFEGUARDS AGAINST PANICS. 



The panic of 1907 afforded a convinc- 
ing demonstration of the inherent weak- 
ness of the banking organization in the 
United States, and awakened for the first 
time a general interest in proposals for 
currency reform. The panic of 1893 had 
occasioned some agitation of the subject 
and the American Bankers' Association, 
meeting at Baltimore in 1894, adopted 
recommendations looking to a more lib- 
eral system of bank issues. What was 
known as the Baltimore plan contem- 
plated issues by all the national banks 
against their general assets instead of 
against government bonds or other speci- 
fied security. In all the later discussion 
of the subject this class of issues has been 
known as "asset currency." The silver 
agitation which came about that time 
postponed the bank note question and 

67 



Opposition to Unsecured Issues 

little progress was made for ten years 
more. 

In 1906 the American Bankers' Asso- 
ciation appointed a commission to deal 
with the subject and in 1907 it ratified 
the action of the commission, which fav- 
ored issues by all the national banks upon 
general assets. At that time, however, it 
was apparent that strong opposition ex- 
isted among bankers as well as in Con- 
gress to a system of unsecured issues by 
thousands of institutions. 

At this stage of the agitation came the 
panic of 1907. To the average business 
man it was like a bolt of lightning from a 
clear sky. The country was prosperous, 
crops were good, industries were busy 
and trade was in a healthy and well-bal- 
anced condition. That credits were not 
generally over-extended was proven by 
the comparatively small number of fail- 
ures, despite the tremendous shock and 
strain of the panic. The crisis came at 
the season of the year when the legitimate 
demands for money and credit were at 

68 



1907 

the highest. Conditions abroad were un- 
favorable to the importation of gold and, 
with no facilities at their command for 
increasing the supply of currency, the 
banks of the central reserve cities were 
unavoidably below their legal reserves of 
cash and in no position to withstand ad- 
ditional and extraordinary demands. 

Up to this time the situation, although 
strained, was not exceptional for that 
season of the year, and what followed in 
1907 might as well have occurred in 1906 
or 1905 or at any time when the banking 
resources of the country were fully em- 
ployed. As it happened at this critical 
juncture in 1907, events transpired which 
created a "run" upon certain banking in- 
stitutions in New York City, and the 
newspaper reports of this started a gen- 
eral movement by banks in the interior 
to withdraw funds from New York, 
partly to strengthen their own cash hold- 
ings and partly no doubt in anticipation 
of what actually followed, to-wit, the re- 

69 



An Emergency Currency 



striction of cash shipments by the New 
York banks. 

With no means at their command for 
converting their assets into currency, and 
facing a demand of immeasurable pro- 
portions, the banks of New York City 
were obliged as a choice of evils to place 
restrictions upon cash payments; the 
banks of the other central reserve and re- 
serve cities found it immediately neces- 
sary to do the same, and the country 
banks generally felt compelled to follow 
their example. It is unnecessary to 
dwell here upon the enormous cost to the 
country of the industrial disorganization 
which followed. 

Confronted by this emergency and 
facing the necessity of satisfying by some 
means the calls of the public for a circu- 
lating medium, the banks acting together 
through the clearing-houses and other 
similar organizations, proceeded to im- 
provise an emergency currency, accept- 
able for local use. The public with a 
most creditable appreciation of the situa- 

70 



The Aldrich-V re eland Act 

tion, accepted these makeshifts as una- 
voidable; confidence in the banks was 
restored by their associated action, and 
gradually normal conditions were re- 
established. 

The lessons of this experience were not 
lost. A demonstration had been afforded, 
not only of the weakness of our banking 
system while its individual members were 
isolated and struggling against each 
other, but of its invincible strength when 
the banks united their credit and adopted 
a common policy. It was quickly recog- 
nized that a remedy for banking crises 
had been found without going back to 
the distrusted system of unsecured indi- 
vidual bank issues. The banks should be 
organized into an effective system and 
the system equipped with the power and 
the instrumentalities to protect and sup- 
port its individual members. 

The first expression of this new policy 
in the form of a statute is found in the 
Aldrich-Vreeland act, a measure avow- 
edly temporary in character, but contain- 

71 



The Monetary Commission 

ing the germ of a new system. Its lead- 
ing feature is the provision under which 
the Comptroller of the Currency, with the 
approval of the Secretary of the Treas- 
ury, may issue currency upon the security 
of certain bonds, but it carries as a subor- 
dinate feature a provision by which the 
banks may form local currency associa- 
tions and these associations may receive 
approved assets from their individual 
members and issue currency upon them. 
The Aldrich-Vreeland act is a cross-over 
track from the bond-secured currencv 
system of the national banking act to a 
system of currency issues based upon 
commercial assets. 

One of the features of the Aldrich- 
Vreeland act was a provision for a Mone- 
tary Commission of eighteen members of 
whom Senator Aldrich and Mr. Vree- 
land, joint authors of the Aldrich-Vree- 
land act, are influential members. Sena- 
tor Aldrich as Chairman has submitted a 
tentative draft of a plan which, subject 
to some suggested modifications, has been 

72 



A National Currency 



formally approved by the Executive 
Council of the American Bankers' Asso- 
ciation. 

The first thing to be said of this plan is 
that it follows, develops and legalizes the 
same general procedure to which the 
banks themselves resorted by common 
consent in 1907. The clearing-house 
cheques of 1907, notwithstanding the 
haste and informality of issue, proved to 
be as safe a currency as national bank 
notes, with the advantage of being based 
upon the natural assets of a commercial 
bank, but they had no legal status or na- 
tional character and could not be used in 
the settlement of balances between locali- 
ties. 

The Commission's plan, adopting the 
same principle of issue but seeking to 
unite all of the banks into one system for 
the exercise of this function, would pro- 
vide a national currency under certain 
definite safeguards which experience has 
shown should always surround issues of 
paper money. 

73 



National Reserve Association 

It is proposed to form what shall be 
called the National Reserve Association 
of America, the capital of which shall be 
provided entirely by the banking institu- 
tions of this country. No other subscrip- 
tions will be received and the banks will 
be allowed to subscribe or acquire stock 
only in a fixed pro-rata of their capital. 
The authorized capital of the Reserve 
Association is to be 20 per cent, of the 
capital of all the banks joining it, each 
bank subscribing that percentage of its 
own capital. In case a bank increases or 
diminishes its capital its shares in the Re- 
serve Association will be increased or 
diminished accordingly. One-half of 
the subscribed capital will be called in 
at first, and the remainder will probably 
never be called for, but the subscriptions 
will stand as a liability of the banks and 
thus serve to fortify the credit and pres- 
tige of the institution in the eyes of the 
world. Assuming that the banks gen- 
erally come into it, the National Reserve 
Association would be much the strong- 

74 



The Plan of Organization 

est organization in the world for the per- 
formance of banking functions. 

It is proposed to allow the Reserve 
Association to pay dividends upon its 
outstanding shares up to five per cent, 
per annum; after which, and after the 
accumulation of a given surplus, all prof- 
its are to be turned into the Treasury of 
the United States. This disposition of 
the earnings is consistent with the theory 
upon which the Association is formed, 
viz : That it is not an institution for prof- 
it, but an association of banks for mutual 
support and assistance in their service to 
their local communities, and to enable the 
banking system as a whole to discharge 
certain public functions which the indi- 
vidual banks cannot so effectively per- 
form. 

The organization of the Reserve Asso- 
ciation is modeled after our federal form 
of government. It begins at the bottom 
with local bank associations, which must 
consist of not less than ten banks and not 
less than $5,000,000 of combined capital 
and surplus; then the entire country is 

75 



Distribution of Control 



divided into fifteen districts and the local 
associations of each district are organized 
into a district association; and finally the 
National Reserve Association, with its 
head office in Washington, is founded 
upon the district associations. The con- 
trol of the local associations is wholly 
within themselves ; the members elect their 
own directors and the directors for each 
district are elected by the banks within 
that district, and, finally, all of the dis- 
tricts participate in the election of di- 
rectors for the national association. The 
plan of choosing directors is ingeniously 
devised throughout to give the small 
banks more influence than they would 
have if their voting power was based 
upon their holdings of capital stock in the 
Association. In the local associations, 
for example, three-fifths of the directors 
are elected by allowing each bank in the 
association one vote regardless of its 
size, while the other two-fifths are 
elected by allowing each bank to cast as 
many votes as it has shares in the asso- 

76 



The Voting Power 



ciation. A similar plan is followed in 
electing directors of the district and na- 
tional associations. 

It is interesting in this connection to 
examine the statistics given in the last re- 
port of the Comptroller of the Currency 
as to the number and capital of national 
banks : 

Number. Capital. 

All National Banks 7,173 $1,002,735,123 

Under $100,000 capital 4,543 183,640,108 

Of $100,000 capital 1,247 124,700,000 

Of $500,000 and over $100,000 

capital 1,079 267,525,000 

Total of $500,000 and 

under 6,869 575,865,108 

Over $500,000 capital 304 426,870,015 

It is apparent that the great number 
of small banks would give them a predom- 
inating influence in choosing a majority 
of the directors. A majority of all the 
capital of national banks is in banks of 
$500,000 capital and less. If the State 
banks generally come into the system the 
strength of the small banks would be 
further increased. It is also to be noted 
in considering the relative influence of 
small and large banks that the latter are 

77 



The National Board 



grouped in a few central cities and that 
in any possible arrangement of fifteen 
districts most of the latter would be con- 
trolled by the banks of moderate capital. 
It would seem to be clear that the small 
and medium-sized banks would have 
ample representation in the management 
of the Reserve Association. 

Provision is made that the district and 
national boards shall each have a number 
of members chosen from outside of the 
banking business who shall fairly repre- 
sent the industrial, commercial and agri- 
cultural interests. 

The national board, which will be com- 
posed of forty-five members, is to contain 
six ex-officio members, to wit: The gov- 
ernor of the Reserve Association, who 
shall be chairman of the board; two 
deputy governors, the Secretary of the 
Treasury, the Secretary of the Depart- 
ment of Commerce and Labor, and the 
Comptroller of the Currency. An ex- 
ecutive committee of nine members is to 
have the powers of the full board and of 

78 



The Chief Function 



these, four, namely, the governor, two 
deputies, and the Comptroller of the Cur- 
rency, are appointed by the President of 
the United States and serve as represen- 
tatives of the public. As submitted, 
therefore, the plan contemplates that a 
very large degree of control will be exer- 
cised by the Government, that complete 
publicity will be given to its affairs and 
that the institution will be essentially a 
public rather than private one in its char- 
acter and responsibilities. 

This is the general plan of the organ- 
ization. Now what is the organization to 
do? The chief function entrusted to it is 
the holding of the reserves of the banks, 
the making of that fund mobile, and thus 
preventing the disastrous scramble for re- 
serves by all the banks individually when- 
ever there is financial stress. Next in im- 
portance is the function of issuing the 
notes of the Association for circulation as 
currency, based in part upon a gold re- 
serve and in part upon short-time com- 
mercial paper. In other words, this or- 

79 



The Note Issuing Power 



ganization is to be charged with the re- 
sponsibility of giving elasticity to our 
currency supply. It will issue its notes 
by re-discounting commercial paper for 
the banks, and under some conditions by 
making direct loans to the banks upon 
collateral security. The note issuing 
power is exercised by the national asso- 
ciation, but through the agency of the 
fifteen branches. It is desirable that 
these fifteen branches shall be directed by 
one responsible authority, rather than 
that they shall be in effect fifteen inde- 
pendent institutions. It is fundamental 
that any system of paper currency shall 
provide for the maintenance of proper re- 
lations between the volume of that cur- 
rency and a gold reserve, and the experi- 
ence of the world has shown that this is 
most certainly accomplished through one 
central authority and by its control over 
a uniform discount rate. The prestige 
and effectiveness of the gold reserve 
would be lost if it was divided among 
fifteen institutions ; and the burden of 

80 



Bank Have Freedom 



meeting all demands would fall directly 
upon the one reserve at the port through 
which our financial intercourse with for- 
eign countries is mainly carried on. It 
follows that we do not want fifteen new 
kinds of currencies or fifteen separate 
gold reserves, or fifteen sets of managers 
with conflicting policies and varying dis- 
count rates. There is the same necessity 
for a supreme authority in control of the 
national gold reserve as for one authority 
over all the Nation's forces of defense. 

This centralization of authority as to 
one vital function does not, however, mean 
a centralization of control over banking 
facilities. The banks of all sections of the 
country will have the same freedom of 
action they have now and will go on 
making their own policies as they have in 
the past, and the field will be open to new 
competitors as heretofore. Furthermore, 
the banking business will be conducted 
with a greater sense of security and with 
more regular and stable policies than the 
individual banks have been able to maii> 

81 



Four Classes of Paper 



tain in the past. In brief, all of the pres- 
ent banking facilities of the country will 
remain, enlarged and strengthened, but 
when the powers of the Reserve Associa- 
tion are called upon they will be admin- 
istered under one consistent policy, by 
rules which will make them equally avail- 
able for all applicants. This is accom- 
plished by regulations strictly defining 
the kinds of paper which the Reserve 
Association may receive, and providing 
that it shall re-discount all the paper of 
certain preferred classes that is offered 
and at a uniform rate. 

The plan describes four distinct classes 
of paper which the National Association 
may receive. Two of these are distinctly 
preferred in that they may be received 
without the endorsement of the local asso- 
ciation, but the conditions upon these 
classes are severe. 

First, the association may re-dis- 
count notes and bills of exchange 
that arise out of commercial trans- 
actions; the first condition being that 



Commercial Paper 



they shall arise out of commercial trans- 
actions. The term "commercial trans- 
actions'' means the class of transactions 
which are incidental to the regular ex- 
changes of the country; the movement of 
the crops to market, the current dis- 
tribution of goods and commodities to 
supply the consumptive demands of the 
people. This paper must not represent 
speculative transactions ; it must not rep- 
resent investment transactions, however 
conservative. Aside from the question of 
security, there are two reasons why paper 
representing fixed investments is barred; 
first, there is no definite limit to the 
amount of such offerings and, second, 
there is no natural or definite maturity for 
such paper. Its payment probably de- 
pends upon a speculative or investment 
demand instead of a consumptive de- 
mand. It is a primary condition of this 
plan, therefore, that no paper will be re- 
discounted save such as in the ordinary 
course of trade will be naturally liqui- 
dated at maturity. 

83 



Most Desirable Loans 



If a merchant with an established trade 
and credit, and with ample capital for the 
ordinary requirements of his business, 
borrows at the season of the year when he 
lays in his heaviest stock and regularly 
pays out later as he reduces his stock; if 
a ^dealer in grain or produce borrows at 
the season when the crop moves from the 
producer's hands and pays out as it is 
distributed for consumption; if a manu- 
facturer borrows at one season to acquire 
materials or to accumulate stock for the 
marketing season and pays out regularly 
at the latter time; these borrowings are 
of the class which are naturally liquidated 
within a definite period. They are the most 
desirable class of loans for a bank to have 
and the class of transactions from which 
they arise is the one which the community 
as a whole is most interested in having 
protected from interruptions. On the 
other hand, if money is borrowed to buy 
land or railway stocks or bonds or to 
build houses, no matter how good these 
investments may be, such borrowings are 

84 



Effect of Provisions 



of another class and are expressly ex- 
cluded from the privilege of re-discount 
by the Reserve Association, although 
they may under exceptional conditions be 
used as the basis of advances. 

But the provision that the paper shall 
arise from commercial transactions is not 
the only restriction upon the first class 
of paper described. This paper must 
have not more than twenty-eight days to 
run. The effect of this provision is to 
make the applicants send in their short 
maturities first and keep the Reserve 
Association as liquid as possible. But 
even this is not all; this paper must have 
been made at least thirty days before it 
was offered to the Association for dis- 
count. The effect of this is to prevent the 
manufacture of paper for the occasion; 
is must be paper taken in the regular 
course of business. And, of course, all 
of this paper must be endorsed by the 
bank which is offering it. 

The other class of paper which may be 
received by the National Association 

85 



Acceptances 



without passing through the local asso- 
ciation consists of what are known as ac- 
ceptances. The only acceptances we have 
now are drafts drawn by one business 
house on another and accepted by the 
latter for payment at a future date; and 
we do not have many of these because 
our system of cash discounts induces the 
best houses to pay cash, borrowing if need 
be from their bankers. Abroad it is the 
common practice for banks to accept 
drafts for their customers, making a 
small charge, commonly one-quarter of 
one per cent, for the service, after which 
the paper is sold on the market. Fur- 
thermore, the popularity of this kind of 
paper abroad has resulted in the develop- 
ment of an intermediate class of bankers, 
known as accepting houses, who make a 
specialty of lending their credit by this 
method. The name of an accepting 
house of known responsibility gives the 
paper wider currency and reduces the 
discount rate by enough to cover its 
charges. 

86 



Desirable Paper 



It is generally agreed among experi- 
enced bankers that nothing would do so 
much to mobilize the credits of this coun- 
try as the introduction of this class of 
commercial paper. It will do more to 
assure an ample supply of credit for 
legitimate and current business at uni- 
form discount rates for all sections, and 
more to provide the banks with genuine 
and high class commercial paper, than 
any other single provision of our bank- 
ing laws. It will give a character and 
fluidity to local credit that it has never 
had in this country and bring bank 
credits more generally into conformity 
with certain accepted rules that are dif- 
ficult of enforcement upon paper of 
purely local circulation. 

All bankers deem it advisable to have 
in their portfolios considerable paper 
originating outside of their depositing 
patrons, because such paper will be paid 
without requests for renewal, and the 
credit situation the country over would 
be improved by having the percentage of 

87 



Not Centralization 



this class of paper increased. The differ- 
ence in rates of discount between paper 
of this class and that which does not have 
access to the general market would be a 
constant object lesson of the value of 
compliance with correct banking prin- 
ciples. 

The fact that the National Reserve 
Association will stand ready to take these 
acceptances and give currency for them 
will give them a broad market and thus 
help the different sections of the country 
to help each other even more than they 
are helped by the Association direct. The 
fact deserves to be emphasized that this 
is not centralization; it is decentraliza- 
tion. The central organization by sup- 
porting all of the banks of the system 
will impart confidence throughout the 
system and enable the members to deal 
with each other. Its influence will be 
against the accumulation of country bank 
funds in the centers, so long as any part 
of the country is wanting credit to finance 
its current business. 

88 



Two Additional Classes of Paper 

Holdings of either class of paper which 
may be re-discounted by the Reserve 
Association direct, will be practically an 
addition to the cash reserves of a bank, 
and this will furnish a constant incentive 
to the banks and to their customers to 
bring their paper to this standard. 

The plan recognizes two additional 
classes of paper, which may be received 
by the National Association when en- 
dorsed by a local association. First, it 
may receive paper arising from com- 
mercial transactions having more than 
28 days, but not more than four months, 
to run. This paper must be passed 
by the officers of the local association to 
which the applying bank belongs and the 
local association must stand behind it if 
it defaults; the members dividing the re- 
sponsibility on the basis of their capital 
and surplus. 

The local association is authorized to 
require security, and the borrowing bank 
is required to pay a commission to the 
local association which shall be fixed from 

89 



At Times a Fourth Class of Paper 

time to time by the board of directors. 

Finally, there is one more class of 
paper which the National Association 
may discount, but only under unusual 
conditions. The three classes heretofore 
named must all arise from commercial 
transactions and it is clearly indicated 
that ordinarily nothing but paper di- 
rectly related to commercial transactions 
will be received. But whenever in the 
opinion of the Governor of the National 
Reserve Association the public interests 
so require, and such opinion is concurred 
in by the executive committee, and the 
Secretary of the Treasury definitely ap- 
proves, the Association may discount the 
direct obligation of a bank, provided that 
obligation is endorsed by the local asso- 
ciation and secured by collateral in its 
hands ; but in no case shall the loan exceed 
two-thirds the value of the security so 
deposited. This class of paper is plainly 
intended only for emergency use and the 
terms of its use are such as to preclude 
offerings under ordinary conditions. 

90 



Objections Answered 



The objections commonly made to 
bank note systems are that they either 
permit inflation by having insufficient re- 
strictions, are inelastic because of arbi- 
tray restrictions, or suggest monopoly by 
fixing control in a single authority. The 
last objection is met in this proposal by 
the plan of organization; it is met 
again, and the other two objections with 
it, by the regulations covering the 
classes of paper which the Reserve Asso- 
ciation may receive. There can be no un- 
due inflation of credit so long as its use 
is confined strictly to commercial pur- 
poses, nor can there be favoritism if all 
demands for these purposes are met at 
a uniform discount rate. 

The rate for re-discounts will be the 
same upon all paper of the same class at 
all offices of the Association and to all 
applicants, and all offerings which comply 
with the conditions will be accepted. If 
in view of present banking conditions in 
this country this promise seems impos- 
sible of fulfillment the answer is that it 

91 



Discount Rate 



has been realized for years in practically 
every other important country of the 
world. 

It has been abundantly demonstrated 
that the demands upon a central re-dis- 
counting institution can be controlled by 
its discount rate. The executive com- 
mittee of the National Reserve Associa- 
tion will have the financial situation 
before it. Its members will know the 
condition of the world's markets; they 
will know whether the foreign exchanges 
are in our favor or against us, whether 
trade is in normal condition or not, 
whether speculation is prevalent or not, 
whether the banks are overloaned or not, 
and the committee can act as a governor 
upon this situation by means of the dis- 
count rate. Its members will occupy an 
independent position, wholly different 
from that of bankers who are competing 
for business. They will be acting for all 
the banks and for the entire community. 
They will not be looking for customers; 
they will not be looking for profits; they 

92 



Government Representation 

will be the guardians of the credit situa- 
tion; they will take all the paper offered 
that complies with the conditions, regu- 
lating the rate to control the demand. 

It is altogether improbable under the 
organization proposed that the provisions 
of law governing rediscounts would be 
deliberately or frequently violated. The 
intent of the restrictions is clear and with 
the publicity that will be given to all the 
operations of the association, the essential 
regulations could not be ignored without 
exposure. High officials of the govern- 
ment are named not only as members of 
the Board of Directors but of the Execu- 
tive Committee, and it is inconceivable 
that they or the other Directors, all of 
whom will presumably be men of charac- 
ter, will permit false statements of the 
association to be made. Responsibilities 
quite as grave as these, and far more dif- 
ficult of administration, are already en- 
trusted to public officials and others are 
daily proposed. 

93 



The Independent Local Bank 

These functions, which it is proposed to 
have the reserve association perform, are 
not in themselves new or experimental. 
The form of the organization is new, and 
planned to avoid any radical change 
in existing banking conditions, and to 
assure all sections of the country of 
proper representation in the manage- 
ment. The principle of a central dis- 
counting organization upon which all 
other banking institutions may rely, with 
authority to issue currency, has been de- 
veloped by a process of evolution and uni- 
versally accepted. The ability to control 
the demand by means of the discount rate 
is fully demonstrated. But in adopting 
this the plan retains what has been the dis- 
tinctive* and essential feature of banking 
in this country, to-wit: the independent, 
local bank, owned and managed in the 
community where it is located. It remains 
the unit of our banking system and the 
plan is devoted to providing an organiza- 

94 



The Weakness of Our Present System 

tion of these units so that they may more 
effectually aid and support each other. It 
aims to accomplish this, moreover, by 
means which will preserve the individual- 
ity of the unit, and offer an incentive to 
good banking, instead of by placing all 
banks on a dead level with an obligation 
to support each other regardless of 
an individual banks character, de- 
serts, or qualifications to conduct a 
a banking business. The weakness of the 
present system is that no matter how 
carefully a bank may be conducted or 
how good its assets may be, it may be 
obliged to suspend payments, because 
conditions wholly beyond its control 
create an unusual demand for cash. These 
conditions may be the result of bad bank- 
ing by reckless competitors. Good banks 
may be obliged to come to the relief of 
such rivals because to allow them to fail 
might seriously disturb financial condi- 
tions. Usually such aid only postpones 

95 



Value of Proposed Plan 



the evil day. Under the proposed plan 
it will be possible for every sound bank 
on the strength of its own assets to obtain 
at any time whatever cash is required to 
meet its obligations. When every good 
bank has the power to protect itself there 
will be no more panics or fear of panics 
and every tub will stand on its own bot- 
tom. 

Vague objections may be raised to 
centralization of power, but there is no 
escape from the weakness and incapacity 
of the present system without creating 
power somewhere. The plan supplies it 
by what would seem to be the most unob- 
jectionable method it is possible to de- 
vise, the use of an agency which the banks 
themselves will control, limited in its func- 
tions and subject to practically complete 
supervision by the government. 

With this organization or one perform- 
ing substantially these functions there is 
little risk in saying that another suspen- 

96 



Helpful in Ordinary Times 

sion of cash payments will never be expe- 
rienced in this country. This in itself is 
of great importance. It would be of in- 
estimable value to all classes and all inter- 
ests to have protection against a repetition 
of the experiences of 1907. But that is 
not all, or even the chief of benefits. 
Fourteen years intervened between the 
panic of 1893 and 1907, but in every year 
of that time the facilities which the Re- 
serve Association will afford would have 
been helpful in many parts of the country, 
particularly in the crop-raising season. 
They will help every community to use 
the credit which it is entitled to use and 
do it under such restrictions and super- 
vision that the banking business of the 
whole country will be in better condition 
than it has ever been heretofore. They 
will enlarge the credit facilities of the 
local banks for all special and temporary 
needs, protect the money markets from 
extreme fluctuations, and make credit 

97 



The Principal Function 



conditions more stable and uniform 
throughout the country. 

An effort has been made in the preced- 
ing addresses to describe the functions of 
banking and the services which the bank- 
ing business is expected to render in the 
modern industrial and commercial sys- 
tem. There can be no adequate compre- 
hension of the pressing necessity for 
banking and currency reform unless these 
functions are understood. Our legisla- 
tion upon this subject in the past has pro- 
ceeded largely upon the theory that the 
principal function of banking is re- 
ceiving and lending money, whereas the 
principal function of banking is dealing 
in credit and the use of money is only 
incidental thereto. Money in all the ordi- 
nary uses of trade is simply a means of 
transferring credits or settling balances. 
The great bulk of the business of the 
world is done without it, except as it 
serves in bank reserves as the touchstone 

98 



The Essential and Fundamental Truth 

of value and as a margin of liquid capital 
that is quickly transferable and available 
anywhere. The essential and fundamen- 
tal truth upon which all business relations 
are based is the fact that the exchanges 
offset and balance themselves. The book- 
keeping function, the service of arrang- 
ing the offsets, disposes of much the 
greater part of all the payments that are 
to be made. This service is performed by 
the banks and the fact that so large a 
proportion of the payments can be settled 
in this manner and without the use of 
money, enables the banks to finance the 
trade of the world so largely upon credit. 

Bank credit is based upon the credit of 
the business public. The banks examine 
and verify and classify the credit of their 
customers and with a margin for error 
are able by the law of averages to create 
upon this basis a higher and more liquid 
form of credit which is placed at the ser- 
vice of the business community. And as 

99 



Highest Form of Credit 



the credit of one bank is usually better 
than that of its individual customers so 
the credit of a group of banks, by the law 
of averages, is better than that of an indi- 
vidual member of the group, and the 
credit of a system which included all or the 
larger part of the banks of a country like 
the United States would be the highest 
form of credit in the world. 

The vital difference between bank 
credit and individual credit is in the fact 
that bank credit is treated as cash. The 
banks so arrange the maturing obligations 
of their customers that they can agree to 
pay all their own obligations on demand, 
and they make good on the promise so 
uniformly that their promises are ac- 
cepted as cash. Their credit therefore, is 
buying power. It is paying power. It does 
everything that money can do. It is more 
liquid and transferable than money it- 
self. When it is understood that the chief 
function of banking is dealing in credit 

100 



Banks Deal in Credit 



and that it is credit, not money, that the 
banks lend, the old fear that the banks 
will control the volume of money and con- 
spire to manipulate it for their own ad- 
vantage becomes absurd. This old fear 
springs from the idea that banking con- 
sists of receiving and lending actual 
money over the counter, when in fact the 
banks lend fifty dollars of credit where 
they lend one of money. The power to 
issue currency does not add in the slightest 
degree to the ability of the banking system 
to manipulate loans. There is not now, 
and in the nature of things never can be, 
any physical obstacle to a conspiracy 
among the banks to manipulate loans, and 
whether they issue currency or not has 
nothing to do with the power to make or 
withhold loans. If there was no money 
in the country but gold coin and United 
States notes the banking business would 
go on and the money would find its way 
into the banks, and the banks would make 

101 



The Pending Movement 



or decline loans just as they do now. 
The power to issue currency has but one 
use in a banking system, namely to supply 
currency to customers when wanted; and 
there is no possible reason why it should 
ever refuse currency when they want it. 
It is simply one form of bank credit and 
the public frequently find it a convenient 
form. 

The movement pending is designed to 
put bank credit in the United States on 
a firmer, more trustworthy basis, than it 
has ever been before. A banking system, 
as we have seen, is an agency for organ- 
izing all of a country's available resources 
as a basis of credit. It accomplishes the 
seeming miracle of enabling capital to be 
in two places at the same time. In other 
words, it enables capital in one form or 
place to stand as a pledge for values or 
activities elsewhere, and as this agency is 
perfected and strengthened the efficiency 
of all our wealth-producing powers are 
correspondingly increased. 

102 



An Admonition 



In conclusion let it be repeated as an 
admonition not to be forgotten for an 
instant that the vital factor in bank credit 
is its availability for use as money any- 
where at a moment's notice. The banking 
credit of the United States can never be 
of the first class while it remains respect- 
able for the banks to suspend payments. 
And not only must they pay in lawful 
currency but that currency must be re- 
deemable in gold and the gold reserve 
must be in sight and ample for the pur- 
pose. The authority to issue the currency 
must be vested in some organization that 
will have the power to maintain such a re- 
serve. When our banks have a never- 
failing currency system at their command 
and the currency system has a never- 
failing gold reserve behind it the United 
States will come into the financial leader- 
ship which by wealth of resources belongs 
to it. 



103 




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